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ABC Costing

ABC Costing

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Published by Ali Basra

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Published by: Ali Basra on Jun 19, 2009
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05/24/2013

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Cost Management Accounting
Requirement of the article: Activity based costing (ABC) is astrategic costing technique with theobjective of demonstrating what makesit a superior costing technique incomparison to the traditional costingtechniques. Discuss the significanceof the philosophy underpinning use of  ABC as a strategic costing technique.
Introduction
Is a costing model that identifies activities in an organization andassigns the cost of each activity resource to all products and servicesaccording to the actual consumption by each: it assigns moreindirect costs(overhead) into cost, However Activity-based costing is a process where costs are assigned due to the cause and effect relationshipbetween costs and the activities that drive costs.Traditional costing systems have a tendency to assign indirect costsbased on something easy to identify (such as direct labor hours). Thismethod to assigning costs can be very inaccurate, as there is notnecessarily a relationship between the costs that are being assigned,and the activity they are being assigned to. This can make evaluatingcosts tricky and inaccurate. Therefore activity base costs identify. Thereis not direct relationship between overhead cost incurred and theproduct services provide to customers. ABC system give visibility to
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Cost Management Accounting
how effectively resources are used and how all activity contribute to thecost of the product services 
Different between Traditional and ABC cost.
 Traditional ABCSalaries $100Clean door $40Equipment $80Paint door $75Supplies $20Inspect door $75Overhead $45Send door to assemble $55 Total $245Total $245As u can see in the example ABC provide information about how cost areactually consumed. ABC did not eliminate or change cost. Using the ABCsystem then a manager could evaluate the costs for each activity andmay decide to combine the some of the steps in order to lower cost.
Definition:-
Activity Base Costing is a costing method that is designed to providemanagers with cost information for the strategic and other decisionsthat potentially affect capacity and therefore “Fixed Cost”. In ABC theobjective is to understand overhead and the profitability of product andcustomers and to manage overhead.
Characteristics:-
It is superior to traditional costing and the rationale behind ABC is thatthe provision of product and services require the performance of activities. The performance of the activities in turn consumes resource. It
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Cost Management Accounting
is use of these resources that generate cost, most of which are overhead(indirect cost).
Benefits of ABC
Activity based costing brings accuracy and reliability in productcost determination by focusing on cause and effect relationship inthe cost incurrence.
Managers manage activities and not products. The changes inactivities lead to changes in costs. Therefore if the activities aremanaged well, costs will fall and resulting product will be morecompetitive.
ABC highlights the problem areas that deserve the management’sattentions and more detailed analysis.
ABC system is used in setting priorities for action.
Makes “Indirect” expenses “Direct”.
The relationship between primary and secondaryoverhead:
If the company wants to reduce the cost then it can reduce the cost bydown sizing of the labor cost. It can be better in condition where thecompany earns more profits. But in situation where demand becominghigh again of the products then recruiting and hiring of the staff andlabor raised the cost again. Here Traditional cost always fails but activitybased costing helped the company to solved the problems because ABCcosting allocating the exact cost pools to the actual products. In resultshigh volumes made in low cost and low volumes made in high cost.
1.Complexity with ABC Costing:
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